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In A Fix At The Fed

June 25, 1995

News: Analysis & Commentary: THE ECONOMY

IN A FIX AT THE FED

It seemed like the ideal time to be a central banker. Just weeks ago, with economic growth moderating from last year's torrid pace and inflation in check, Federal Reserve Chairman Alan Greenspan was confident he had piloted the economy to a soft landing that would require no change in interest rates over the coming months. After spending most of his tenure coping with a banking crisis, a recession, a low-growth expansion, and a stock market crash, he looked to have a smooth summer ahead.

Forget the beach. A flurry of unexpectedly downbeat economic news, including a jarring June 2 report of May job losses, has put Greenspan on alert. He's feeling heat to pull the sputtering economy out of its current dive by cutting interest rates as early as July.

PANETTA'S SALVO. The pressure is coming from all sides: a Fed colleague who went public with concerns about the economy, a White House nervous about waging a reelection campaign in a weak economy, and corporate executives urging the Fed to reopen the flow of credit. "You turn off the spigot, and you can't turn it back on so easily," says Stanley C. Gault, chairman of Goodyear Tire & Rubber Co. "It would help if they lowered rates." And with yields on two-year and five-year bonds now below the overnight rate the central bank controls, traders have fully priced in a Fed rate cut. "If the Fed doesn't align its policy with the markets, it puts itself in a position of being blamed for exacerbating the slowdown," says David H. Resler, chief economist for Nomura Securities Co.

For Greenspan, there's even more at stake. It is widely assumed in Washington that the Fed chairman would like to be reappointed to a third four-year term next March. But neither Bill Clinton nor the Republican-controlled Senate, which confirms Fed nominees, will be inclined to renew the 69-year-old economist's contract if growth doesn't snap back smartly. "If Greenspan cares about his reappointment, he doesn't want this economy to go into recession," says one former Fed governor.

Just to underscore the political pressures, the White House broke a two-year moratorium on jawboning the Fed when White House Chief of Staff Leon E. Panetta urged the central bank on June 11 to cut the 6% federal-funds rate banks charge one another for overnight loans. President Clinton's advisers insist that Panetta's remarks were spontaneous and not the start of an anti-Fed campaign. "He was careless in how he responded," says Treasury Secretary Robert E. Rubin. "People may slip." Still, others don't regret Panetta's salvo. "It was not a bad idea to send a little signal," admits one White House aide.

There are likely to be plenty more signals if the Fed doesn't get the hint. And if sniping from the White House is not enough, Greenspan has to worry about tensions building within the Fed, which until recently had maintained a united front on monetary policy. Already, some Fed policymakers are second-guessing their last rate hike--a half-point move in February amid initial signs the economy was starting to cool. "If that meeting were held again, we would not [make] the same decision, knowing what we know now," concedes one insider.

Meanwhile, Fed Vice-Chairman Alan S. Blinder, a former Clinton economic adviser, appeared to be lobbying publicly for a rate cut when he told Reuters on June 6 that the odds of a recession had risen and that he was "more concerned now about the downside [risk to the economy] than the upside" risk of inflation. That candid assessment riled some of his former Administration colleagues, who have maintained an upbeat posture on the economy. His comments were also read by the Clintonites, Wall Street, and former Fed officials as a thinly veiled call on Greenspan to reverse course. "It seems clear that Blinder is beginning to make his case for an early move," says David M. Jones, chief economist for Aubrey G. Lanston & Co.

A proponent of the "preemptive easing" approach, Blinder seems eager for the Fed to begin cutting rates early enough to avert a slump--even if price pressures are still building. "This is a big thing going on between Greenspan and Blinder," says one Administration official, who claims Blinder argued against the February rate hike before grudgingly voting with the majority. "I'm surprised by the recriminations."

Greenspan pursued a preemptive easing in 1989 but was too late to prevent a recession. Now, he appears more optimistic than Blinder that the economy will bounce back from its doldrums, perhaps by fall. At a Seattle press conference on June 7, Greenspan called the slowdown "desirable," reasoning it would probably help the U.S. work off excess inventories that would otherwise tip the economy into recession.

The divergence in Blinder's and Greenspan's views--though carefully nuanced in Fedspeak--was one of those rare differences that spill out into the open. "It is almost reminiscent of the Preston Martin-Paul Volcker days," says former Fed Governor Wayne D. Angell, now chief economist at Bear, Stearns & Co. Like Volcker and Martin, who as chairman and vice-chairman openly argued over policy in the early 1980s, "Blinder and Greenspan are willing to have the public discern a difference in their views," Angell adds.

But if Blinder indeed is leaning toward easing policy, he appears to be in the minority, at least for now. Following his public remarks, other Fed officials hinted that they are in no rush to begin unwinding the seven rate hikes that doubled the fed-funds rate from 3% at the start of 1994 (table). Fed Governor Lawrence B. Lindsey dismissed criticism that the Fed overtightened: "I think we did a pretty good job," he declared in a June 8 speech. The same day, Edward G. Boehne, president of the Federal Reserve Bank of Philadelphia, said he believes the economy will perk up this fall.

MOMENT OF DECISION. Privately, Fed officials say Greenspan doesn't want to be in a situation where he cuts rates prematurely, the economy builds up a new head of steam, and the central bank finds it has to hike rates again in the heat of a Presidential campaign. Fed watchers concur. "Greenspan realizes that going into an election year, he can't reverse any rate cuts without massive criticism from the White House," says Jones. "He wants to be fairly sure of himself before he takes the plunge." Although many analysts believe growth in the second quarter could dip below 1.5%--and even move into negative territory--Fed officials hope the sharp plunge in yields on the benchmark 30-year Treasury, from 8.25% last November to 6.57% on June 14, will be enough to spur the economy.

For Greenspan, the moment of decision for the economy, and his job future, could come in early July. The rate-setting Federal Open Market Committee meets on July 5-6, and the key Labor Dept. payroll survey for June will be released on July 7. Another jobs drop atop the 101,000 May loss is sure to intensify the pressure to reverse course in a hurry.

That's not the prospect Greenspan had in mind in early spring, when all he saw on the horizon were blue skies. But with the economy losing altitude, the pressures are mounting on the Fed to cut rates, and soon. For the chairman, that could mean a long, hot summer.

Reading the Fed's Tea Leaves

Will the Federal Reserve cut short-term rates? In public statements and interviews, Fed officials have opposing views. Here is a scorecard:

ALAN GREENSPAN CHAIRMAN

Says current "pronounced" slowing is "inevitable but desirable" if it allows companies to work down high inventories. Thanks to the slowdown, the "probability of an inventory recession...has decreased significantly."

NO

ALAN BLINDER VICE-CHAIRMAN

Sparked unusual discussion among Fed policymakers by saying publicly on June 6 that he's "more concerned now about the downside [risk to the economy] than the upside" risk of higher inflation.

YES

LAWRENCE LINDSEY GOVERNOR

Dismisses talk that the Fed tightened too much: "I think we did a pretty good job." Says growth could slow to an average 1.5% over the next six quarters, providing the economy with needed capacity.